Demographic Effects

Last week financial press had two interesting articles about economic effects of declining populations. FT mentioned a paper by Masaaki Shirakawa, former governor of BoJ, where he claims that decline in a country’s working age population leads to deflation. Older people spend less than the young, and take less debt. As a result, domestic demand falls and deflationary pressures build. This is where the second article picks up. A research paper quoted in Reuters claimed that monetary policy becomes less effective as societies age. Older people save more, borrow less and therefore are less sensitive to interest rate changes than the young. Therefore, as societies age, central banks have to pull harder to achieve the same end results.

Central banks in ageing western (and some Asian) countries are already doing that. Policy rates are at historic low and for historic long. QE, a different version of the same concept of cheaper debt, also has no end in sight. The effect is higher investment flows leading to asset price inflation, and potentially a bubble somewhere. That somewhere may well be developing markets. Huge amount of hot money inflow is having destabilizing effect in these countries. Asset price inflation with possible asset bubble is one such effect. Higher interest rate volatility and market uncertainty are others.

The second observation of fall in domestic demand in ageing countries also suggests that these economies may need to be rebalanced away from credit fueled domestic consumption. Then, fiscal policies become more important for economic growth. Also, deflation may only be a mechanism to shrink industry down to demand level. Then, central banks might want to rethink their stance of fighting deflation by all means. Net conclusion – rethink current monetary policies.